Post-Rate Cut: RMB, A-Shares Weak
On July 22, a surprising shift in monetary policy emerged from China's central bank as they enacted an unexpected interest rate cut. The People’s Bank of China (PBOC) lowered the seven-day reverse repurchase agreement rate from 1.8% to 1.7%. This cut extended to the benchmark loan market quotation rates (LPR), which saw reductions of 10 basis points for both the one-year and five-year terms. In the wake of this announcement, the offshore Chinese yuan began to experience a noticeable weakening, nearly reaching the 7.3 mark against the US dollar. On the following day, July 23, the Shanghai Composite Index plummeted by 1.65% to close at 2915.37 points, reflecting growing concerns among investors.
As of July 23, 5:30 PM Beijing time, the exchange rate for the US dollar was reported at 7.2867 against the offshore yuan, peaking at 7.2973. In the same period, the onshore yuan stood at 7.2743. Northbound capital, a term referring to funds flowing into China from Hong Kong via the Stock Connect program, exhibited net outflows nearing 4.2 billion yuan on July 23, and reported a cumulative net outflow of nearly 20 billion yuan for the month. After a period of high demand for high-dividend and high-yield stocks, these investments recently began to pull back. However, banking stocks exhibited a counterbalance, rallying in the face of the overall market downturn.
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According to UBS China A-share strategist Meng Lei, both public mutual funds and foreign investors currently hold relatively low positions in high-dividend themes, with their focus primarily targeted on sectors such as insurance and exchange-traded funds (ETFs). While it is plausible for these entities to engage in short-term profit-taking, the prevailing environment of low bond yields and market interest rates makes it challenging for institutional investors to identify suitable alternative investment options.
As the yuan traded lower in the short term, the primary factor contributing to this trend was not solely the cut in interest rates. The rebounding US dollar index was also placing substantial pressure on the yuan. Since June 28, the dollar index had receded by nearly 2%, nearing the losses seen between mid-April and mid-May. Despite a recent downturn in the dollar, short-term overnight interest rates in the US showed a decline, indicating increased market confidence in forthcoming rate cuts by the Federal Reserve anticipated in September.
Eric Robertsen, the global chief strategist at Standard Chartered, reflected on the probabilities of the dollar weakening with the onset of a Federal Reserve rate cut. Notably, the one-year/one-year overnight index swap rate has receded approximately 100 basis points from its peak in May, with current market expectations of a cumulative reduction of 165 basis points before the end of 2025. "To see prolonged depreciation of the dollar, the Fed would need to implement more considerable cuts," Robertsen stated. Furthermore, for Asian currencies, including the yuan, to exhibit strength, he emphasized that a better performance of the Japanese yen is essential to foster a broader risk appetite for emerging markets.
The current geopolitical climate and the underlying fundamentals of the Chinese economy are also influencing the yuan's performance, contributing to a notable apprehension among investors. With concerns regarding potential tariff hikes from the US lingering, risk sentiment surrounding currencies of trade-reliant economies, particularly those in Asia, remains subdued.
On the economic data front, the core Personal Consumption Expenditures (PCE) index is scheduled for release on Friday. David Scutt, a senior strategist at the brokerage firm GAIN Capital, shared insights, stating, "Unless we observe substantial deviations from the 0.2% month-on-month increase forecasted, the index may not serve as a pivotal market mover as previously seen." Previous CPI and PPI readings suggested limited likelihood for unexpected upward movements. Attention now shifts toward economic activity, making the preliminary GDP report for the second quarter all the more significant.
Scutt noted the continued increase of the dollar against the yuan over the past fortnight, attracting buy orders as it broke below the 50-day moving average. This level has acted as a significant resistance point, specifically the resistance level at 7.29250 since early July. Failure to maintain this level could lead to a re-testing of the 2024 high at 7.3114.
Moreover, a currency trader from a major Chinese bank indicated that the seasonal demand for foreign currency, driven by payouts from overseas listings, remittances from foreign companies, and summer travel, tends to influence the strength of the yuan. This seasonal factor often leads to a temporary depreciation of the currency from June to August. Post this seasonality, a modest strengthening of the yuan is expected in the fourth quarter, contingent on the prevailing geopolitical dynamics.
In tandem with these currency movements, the northbound capital outflow reflects broader trends in market sentiments regarding high-dividend stocks. Since June, the northbound capital has exhibited a pattern of net outflows, with single-day sales hitting 5.979 billion yuan on the 22nd and almost 4.2 billion on the 23rd. By examining the sector holdings, it is noteworthy that sectors like food and beverage, electronics, banking, pharmaceuticals, and household appliances accounted for roughly 53.99% of overall market value by the northbound funds.
A marked trend has captivated the market’s attention: high-dividend stocks, which led the gains earlier in the year, have undergone significant corrections, particularly within sectors such as coal, oil and gas, and telecommunications. This leads to renewed discussions on whether the high-dividend factor has reached a point of stagnation.
Market participants from private equity firms have suggested that the observed pullback in high-dividend sectors may not solely revolve around the dividend factor itself, but also be influenced by sector-specific dynamics. The high-dividend theme has seen substantial growth, and given this strong performance, a natural correction is anticipated. Investors are advised to employ caution when selecting high-dividend stocks, focusing on both profitability and dividend sustainability rather than just yield. Consequently, stable earners with potent dividend potentials may unveil better opportunities amidst current market volatility.
Previously, Winnie Wu, an equity strategist at Bank of America for Chinese stocks, commented on the changing winds surrounding high-dividend themes. According to her insights, the national enterprise theme, spurred by dividends, may take a momentary pause as positioning has become somewhat congested. In the past, foreign investors rarely ventured into banking stocks, but present-day consensus suggests a considerable interest in this sector now. Moreover, as dividends for state-owned enterprises have increased significantly, stocks within the coal and gas sectors have surged by 20% and 40% year-to-date, respectively. As the dividend yield for certain companies has retracted from a peak of 10% to under 7%, and in some cases as low as 5%, Wu emphasizes that opportunities lie in positioning for high-quality companies at lower price points.
Finally, Meng Lei asserts that high-dividend investments continue to lack viable alternatives and remains optimistic toward this theme in the medium to long term. Examining sector specifics, such as coal and banking, he notes that public mutual funds still maintain relatively low exposure to high-dividend stocks. Despite banks being increased positions, they still seem below optimal allocation levels. This absence of participation from public funds implies that the recent banking sector rebound may derive its strength from long-term capital sources like ETFs and insurance firms. The long-term investment nature of these entities aligns with their focus on stabilizing returns instead of fleeting price movements in stocks.
As for valuation dynamics, UBS's research indicates that whether assessed by Price-Earnings (PE) or Price-Book (PB) ratios, state-owned enterprises currently sit at about half the valuation of their private counterparts, suggesting that there remains a significant undervaluation opportunity for investors within this sector.